Tax season means RRSP season too!
While the first 60 days of every year tend to be the “Top up” season for financially savvy Canadians, there are people who don't seem to care about the Registered Retirement Savings Plan (RRSP) deadline and choose to remain to belong to the sort of “Anti-RRSP” crowd.
After more than 60 years of existence (it was launched in 1957), it is surprising, that RRSP Program is still widely misundersood by a lot of Canadians. In January 2018, a poll was conducted by CIBC and according to the report made by Jamie Golombek, Managing Director of Tax & Estate Planning for CIBC Financial Planning and Advice, RRSP isn’t as popular as it used to be. He estimated that between 2000 and 2013, the total value of RRSP for individuals aged 25 to 54 dropped to 26%. By 2015, unused RRSP contribution room exceeded a whopping $1 trillion!
Having the opportunity to talk to different clients almost every day, I will normally hear comments about the lack of benefits of RRSPs and it is very evident that more and more Canadians are eschewing RRSP contributions in favor of Tax-Free Savings Account (TFSA).
While it is true that for some people, putting their money into a TFSA would make more sense, there are many others who choose not to have a RRSP account because of their misapprehensions about RRSP. It’s either they do not understand how to use it to their advantage or they got a bad advice because they didn’t talk to the right people (unfortunately this happens to be the most common reason I see from the people I meet.)
In Golombek’s report, he identified six (6) myths manifested around RRSP, I will not attempt to dispel them in these article, instead I will highlight the top 3 persistent RRSP tales that I hear from the people that I meet which confuses them whether there is any point to contribute to RRSP.
Myth No. 1: There’s no point investing in an RRSP – you pay all the savings back in taxes when you retire anyway.
Even in the 2018 CIBC poll, this seems to be the most popular myth, the poll found that 39% of the survey respondents believe that it is pointless to have an RRSP, as they will you’ll pay back all of the savings in taxes anyway. But Golombek pointed out that it is completely inaccurate because there are actually a number of tax-related reasons to contribute to an RRSP: (1) you get an upfront tax deduction the year you contribute to your RRSP; (2) the investments held in your RRSP contribution can get a long-term deferred tax on all the investment income; and (3) if your tax rate is lower in the year of the withdrawal, you’ll get an even better after-tax rate of return on your RRSP investment.
RRSP is not a scam, in fact it can be the most powerful retirement savings vehicle and has gotten a bad rap because of some misguided thinking regarding its withdrawal, taxes and the introduction of what appears to be a better savings vehicle which is the TFSA.
Myth No. 2: It’s better to invest in a TFSA than in an RRSP.
The CIBC poll found that 57% of the respondents believe its better to invest in a TFSA than an RRSP while 67% believe TFSAs are better tax-savings vehicle because they are completely tax-free. However, certified financial planner, Robb Engen believe that RRSPs and TFSAs are mirror image of each other. With TFSAs, your contributions are not tax deductible as they are with an RRSP; but when you withdraw your money, you won’t have to pay tax on it as you will with an RRSP.
According to Golombek, the basic rule of thumb is that an RRSP is generally a better choice than a TFSA if you expect to have a lower tax rate in retirement. This is particularly likely if you are a baby boomer in your peak earning years and expect lower income when you are no longer working.
However, there are a few special situations where TFSA may be a better choice than an RRSP, such as those people who are in a lower tax bracket, people who are early in their income-earning years or if you expect a higher tax rate upon withdrawal or will face clawback (repayment) of OAS or GIS benefit. Even so, you may not be able to save enough in a TFSA alone and may also need to save in an RRSP.
Myth No. 3: I don’t need an RRSP because I’ll have other sources of retirement income.
CIBC found that 49% of Canadians who participated in the poll don’t expect to use RRSP as their main source of income upon retirement and 40% of them including 1/3 of those who are age 55 or older do not have an RRSP. Respondents listed other assets that would likely provide retirement income, including equity in a home (19%), non-registered savings (18%) and real estate or rental properties (15%). Notably, 13% of respondents (including 6% of those ages 75 and older) did not know what their major source of retirement income would be.
Although, there are alternatives to RRSPs, these investment vehicles cannot beat the ease, diversification and tax-deferred advantages of RRSP. Also, if you wish to retire in style you need to have a formal and detailed plan to determine what expenses you might expect in retirement and the amount of income that you may receive from government and private pensions.
According to Golombek, if a shortfall of income to cover your expenses is projected, you may need to use personal investments to fill the retirement funding gap. For many Canadians, the RRSP should be top on the list for retirement savings. He recommends consulting a financial professional to plan out the best course of action to fund your retirement goals.
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Many (if not most) Canadians are missing out their RRSP savings opportunities because they don’t fully understand the tax advantages and consequences of having and using an RRSP. Holding on to unfounded RRSP myths and getting advise from un-informed people creates more confusion and will further keep you from putting your retirement savings plan in order.
Missing the March 1 deadline for this year to be eligible for the 2019 taxes doesn’t mean you should stop striving to put your retirement savings goals in order, March 2 is a good day to start saving for your “golden years.”
In Defence of RRSPs: Dispelling common myths, access on February 18, 2020.